Protecting Your Business from Bankrupt Customers

AUTHOR:
Dan Drechsel

DATE: 09/22/2009

It’s clear that almost one year after the economic meltdown, America is still recovering. However, by many accounts, the economy is bottoming out – making now the time to reflect on lessons learned from the economic crisis that will serve to better prepare business owners should they find themselves in this situation again. One extremely important tactic for entrepreneurs to consider is protecting their businesses from the negative effects of bankrupt customers.

It is more important than ever to evaluate the financial standing of customers to ensure that the credit that is administered to them is safe. According to BankruptcyData.com, there have been more than 180 bankruptcies by major public and private companies in 2009 alone. And, in light of the recent news from CIT Group, one of the largest credit protection providers in the US, it’s clear that traditional avenues for credit protection should be supplemented by putting standards and practices in place that prevent businesses from selling to risky customers.

How can business owners manage this on top of countless other responsibilities? Here are a few tips for how small businesses can get started.

1. Evaluate Your Current Financial Situation

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Before evaluating any of your customers’ financial situations, you should begin by doing a thorough analysis of your own strengths and weaknesses. First, determine your company’s spending habits and decide where you can cut back on spending and where you should invest. Then, decide where you stack up against competitors. What do you offer that your competitors do not? What draws your customers to your business? And, most importantly, who are your customers now?

There are a variety of programs on the market that will automate this process and provide a deep analysis of a business’s financial standing with just a few clicks. One helpful tool is the Business Analytics feature that is built into Peachtree by Sage 2010. This software helps businesses make more informed financial decisions, track financial trends and compare financial standing with competitors.

2. Identify Target Customers

Next, do your best to determine the type of customer that will move your business forward by driving revenues and enabling growth. In the beginning, entrepreneurs tend to accept any customers they can get. However, this often leads to bad debt – meaning you’ve sold (or lent in the case of B2B businesses) to customers that may not be able to carry out payment. Thus, it’s important to ask – what type of customers will likely provide you with the most promising, recurring business and continue to build upon your pipeline of sales?

Until now, it might have been sufficient to rely heavily on the opinion of the sales team to determine if some customers are worthy of credit. Businesses often don’t feel empowered to inquire about the financial status of potential customers. And, it’s difficult to have this insight without any procedures in place. However, thanks to innovative technologies and resources such as D&B Stress Indicator, Equifax bankruptcy predictor and credit outsourcing, small businesses can make better informed decisions on to whom they sell to.

3. Manage Accounts Receivable

Consider this: It typically takes a small business 56 days to get paid by its customers. For a company selling $25,000/week, that’s eight weeks of sales outstanding, which equals $200,000 in untouchable assets. But if a customer goes bankrupt during this time, that money may be lost forever.

One way to ensure that this money is accounted for is by using an accounts receivable credit management solution. Just like when a B2C company accepts a credit card for payment, third-party management of accounts receivable puts the risk and responsibility of collection on a vendor instead of a business. By working with financial institutions, you can borrow against your A/R, and get that capital upfront. In some cases, businesses get paid in as few as four business days, which eliminates the hassle of slow paying or financially unstable customers while also increasing a business’ cash-on-hand and promoting growth.

4. Protect Your Investments

Credit insurance has been the most popular way for small businesses to protect their investments for years. But in light of recent news from traditional credit protection providers like CIT, entrepreneurs should implement standards of their own that serve to protect themselves from unpaid loans. For instance, B2B companies can institute a credit scoring model that identifies the credit standing of their customers and provides them with guidelines for whom to sell to.

A credit scoring model uses front-end credit information to qualify customers, eliminating the need to buy blanket insurance on all of a business’s trade credit. This is a similar strategy to how B2C companies issue individual credit checks before extending personal credit, allowing small businesses to make better-informed decisions on which customers are worthy of credit. Credit scoring models also enable small businesses to continuously monitor the credit-worthiness of their customers – alerting them to any changes in credit standing that could negatively affect their business.

It’s no short order to protect your business from the negative effects of financially unstable or bankrupt customers. However, the effects of the current economic crisis have highlighted the need for entrepreneurs to take extra precaution in how they provide products and services to others. Instituting a plan to protect your business can be done quickly and efficiently with the right tools and could be the defining factor of the business’s survival should the economy take a turn for the worse.